Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Rise of the Originate-to-Distribute Model and the Role of Banks in Financial Intermediation

Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Rise of the Originate-to-Distribute Model and the Role of Banks in Financial Intermediation

Article excerpt

1. Introduction

Historically, banks used deposits to fund loans that they then kept on their balance sheets until maturity. Over time, however, this model of banking started to change. Banks began expanding their funding sources to include bond financing, commercial paper financing, and repurchase agreement (repo) funding. They also began to replace their traditional originate-to-hold model of lending with the socalled originate-to-distribute model. Initially, banks limited the distribution model to mortgages, credit card credits, and car and student loans, but over time they started to apply it to corporate loans. This article documents how banks adopted the originate-to-distribute model in their corporate lending business and provides evidence of the effect that this shifthas had on the growth of nonbank financial intermediation.

Banks first started "distributing" the corporate loans they originated by syndicating loans and also by selling them in the secondary loan market.1 More recently, the growth of the market for collateralized loan obligations (CLOs) has provided banks with yet another venue for distributing the loans that they originate. In principle, banks could create CLOs using the loans they originated, but it appears they prefer to use collateral managers-usually investment management companies-that put together CLOs by acquiring loans, some at the time of syndication and others in the secondary loan market.2

Banks' increasing use of the originate-to-distribute model has been critical to the growth of the syndicated loan market, of the secondary loan market, and of collateralized loan obligations in the United States. The syndicated loan market rose from a mere $339 billion in 1988 to $2.2 trillion in 2007, the year the market reached its peak. The secondary loan market, in turn, evolved from a market in which banks participated occasionally, most often by selling loans to other banks through individually negotiated deals, to an active, dealer-driven market where loans are sold and traded much like other debt securities that trade over the counter. The volume of loan trading increased from $8 billion in 1991 to $176 billion in 2005.3 The securitization of corporate loans also experienced spectacular growth in the years that preceded the financial crisis. Before 2003, the annual volume of new CLOs issued in the United States rarely surpassed $20 billion. After that, loan securitization grew rapidly, topping $180 billion in 2007.

Investigating the extent of U.S. banks' adoption of the originate-to-distribute model in corporate lending has proved difficult because of data limitations. Thomson Reuters Loan Pricing Corporation's DealScan database, arguably the most comprehensive data source on the syndicated loan market and the source used by many researchers in the past, imposes serious limitations on the investigation of this issue. This database includes information available only at the time of loan origination, making it impossible to use it to investigate what happens to the loan after origination. Furthermore, DealScan has very limited information on investors' loan shares at the time of origination. The information on the credit shares that each syndicate participant holds is sparse, and even the information on the share that the lead bank-the bank that sets the terms of the loan-retains at origination is missing for 71 percent of all DealScan credits.

The Loan Syndication Trading Association database contains micro information on the loans traded in the secondary market, but it has no information about the identity of the seller(s) or buyer(s), ruling out its use to close the information gaps in DealScan. Financial statements filed with the Federal Reserve, in turn, contain information only on the credit that banks keep on their balance sheets and thus cannot be used to ascertain the volume of credit that banks originate. These statements contain information on the loans that banks hold for sale, but, as Cetorelli and Peristiani (2012) explain in detail elsewhere in this volume, this variable provides limited information on the extent to which banks have replaced the originate-to-hold model with the originate-to-distribute model in their lending business. …

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